In the case of termination by the Contracting Authority on the grounds of Private Partner default, market practice is that the PPP Contract should expressly provide for some amount of compensation. While this may at first seem at odds with the reason for termination, there is in fact some strong justification:
(a) the Contracting Authority could otherwise benefit from a Private Partner default by unjust enrichment (e.g. taking a built asset without having paid for it) and could in theory be incentivised to terminate the PPP Contract. This could result in legal proceedings being brought by the Private Partner which may ultimately result in the Contracting Authority being liable to pay compensation, as well as legal costs incurred;
(b) without the certainty of an express provision, the Private Partner will likely have to price more risk into its bid and therefore the Contracting Authority will be paying more in the ordinary course of the PPP Contract even though termination on these grounds may never happen;
(c) market practice shows that Lenders are typically reluctant to agree to finance a PPP Project constructed and operated by an SPV where no compensation is expressly payable to them in these circumstances (i.e. the PPP Project will not be bankable). While there is an argument that the risk of no compensation will encourage Lenders to step in and rescue a troubled PPP Project (and there have been some examples of this contractual approach in some early PPP Contracts in the UK, for example), the market has in general moved away from this for the reasons above; and
(d) the Private Partner still usually loses its equity investment and the return on its equity which is its main driver for undertaking the PPP Project in the first place. See Section 4.7, Sample Drafting 4, Schedule, Clause (2).
The Contracting Authority will want to weigh up the likelihood of the termination payment arising against the benefit of procuring private finance. In doing so, the following factors are relevant:
(i) the Contracting Authority has control over serving the termination notice that triggers such payment - this will also be a factor in its favour in bringing all parties to the negotiating table in a potential termination scenario; and
(ii) the Contracting Authority has the ability to mitigate against the risk of Private Partner default even before the PPP Contract is signed, by selecting the Private Partner after a thorough and fair procurement process and evaluation of the soundness of all elements of its bid.